The forthcoming Budget on the 30 October has led to understandable concern amongst share sellers about potential hikes in the Capital Gains Tax (CGT) rate. Whilst the timing of transactions can in some cases be accelerated, there is still the issue of deferred consideration and how to lock-in the existing CGT rates to such consideration.
Traditionally, the focus has, to an extent, been upon deferring the liability to CGT until deferred consideration is received and the use of non-qualifying corporate bond (non-QCB) loan notes has been integral to that. The one exception has been the ability to make elections in respect of QCB’s/non QCB’s/share exchanges in cases where there was the ability to utilise Business Asset Disposal Relief (formerly entrepreneurs’ relief) fully. Consequently, the potential rate changes alter this traditional approach.
What timing strategies are there in respect of deferred consideration?
If the seller is entitled to fixed sums which are contingent upon certain events, the seller is taxed for CGT purposes as if they are entitled to receive such sum with no discount or allowance given for the fact that the sum is contingent. For example, if the Share Purchase Agreement (SPA) provides that a fixed sum is payable on earnings before interest, taxes, depreciation and amortisation (EBITDA) of £x being achieved in 2026, the fixed sum would form part of the initial taxable proceeds notwithstanding the fact that it is contingent. This approach banks the CGT rate in force at the time of the SPA (assuming the SPA is an unconditional sale agreement). If the contingency is not achieved, the seller is able to adjust their disposal proceeds for CGT purposes through a claim under self-assessment. There are variants to this approach which achieve the same objectives such as the provision of consideration based upon assumed future financial performance of target with consideration reduced if financial warranties are not met.
If there is earnout consideration which is unascertainable (e.g. the amount is determined pursuant to a formula referrable to a future accounts period) and it may be paid in cash, the value of the earnout right normally forms part of the taxable proceeds for CGT purposes and is taxed accordingly with the initial cash proceeds. If and when the earnout consideration is paid, this represents a further taxable event with the effect that if the consideration paid is higher or lower than the value accorded to the earnout right, a capital gain or capital loss (as applicable) arises. There may now be a greater focus on determining a higher-end valuation of the earnout right itself to provide greater exposure of the gain to current CGT rates.
Of course, there is a cash-flow disadvantage of the above approaches in terms of the acceleration of CGT on cash proceeds not yet received. The timing of the contingency and the quantum of the consideration may affect the approach taken.
What about the issue of consideration shares or loan notes?
An important point to highlight is that where a seller receives deferred consideration in the form of shares or loan notes issued by the buyer and certain conditions are satisfied, then absent an election for the purposes of Business Asset Disposal Relief, there is no disposal of the shares allocable to that consideration. Instead, no taxable gain arises (CGT event) until there is a disposal of the consideration shares or loan notes (this also extends to an earnout right which is only satisfied in shares or loan notes). Such proceeds are exposed to the CGT rate applicable at that time.
